publication . Article . 2008

Informed Traders as Liquidity Providers: Anonymity, Liquidity and Price Formation

Barbara Rindi;
Open Access
  • Published: 01 Jan 2008 Journal: Review of Finance, volume 12, pages 497-532 (issn: 1572-3097, eissn: 1573-692X, Copyright policy)
  • Publisher: Oxford University Press (OUP)
Abstract
The tendency to introduce anonymity into financial markets apparently runs counter to the theory supporting transparency. This paper studies the impact of pre-trade transparency on liquidity in a market where risk-averse traders accommodate the liquidity demand of noise traders. When some risk-averse investors become informed, an adverse selection problem ensues for the others, making them reluctant to supply liquidity. Hence the disclosure of traders' identities improves liquidity by mitigating adverse selection. However, informed investors are effective liquidity suppliers, as their adverse selection and inventory costs are minimized. With endogenous informati...
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Subjects
free text keywords: Liquidity premium, Market liquidity, Third market, Liquidity crisis, Accounting liquidity, Adverse selection, Economics, Financial economics, Information asymmetry, Liquidity risk
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